For all practical purposes, India is in negative-growth mode. Industrial production is down for the first time in two decades. Exports fell by 20% last month. At least 1.5 million officially-employed workers are expected to lose their jobs within this quarter; the comparative figure from the casual-labour sector will exceed 10 million, and another 12 million Indians will enter the workforce this year. In the diamond polishing industry alone, 14,000 factories have been shut down; another 10,000 will follow suit in forthcoming weeks. Thousands of small-scale outfits supporting textile and machinery exporters have entered bankruptcy. How, you may well wonder, are New Delhi spokesmen adamantly maintaining their target for 7.1% GDP growth in 2009?
“We have entered an extraordinary situation,” Finance Minister Pranab Mukherjee declared in the Indian parliament, referring to the 26/11 terrorist attacks in Mumbai. “Extraordinary times call for extraordinary measures.” The Interim Budget announced by Mr. Mukherjee provided for a 35% increase in defence expenditures; for the full year, defence spending is targeted to rise by a remarkable 80%-plus.
A worried market analyst at the Bombay Stock Exchange who was looking for additional measures directed at stimulating the Indian economy questioned why “the government failed to incorporate any genuine economic stimulus in the Interim Budget, and why the focus was on defence and agriculture?”
She probably ignored the fact that the biggest challenge for the Congress-led government is to find a way to win the forthcoming general elections, due in April-May, not the Indian economy. That focus on votes was evident in the crop-price support mechanisms and farmer-debt write-offs in the Interim Budget. Indian National Congress strategists concede that the task of winning over voters in India’s cities and townships has become a messy proposition, given the continuing (and sporadic) popularity of right-wing Hindu extremists, regional and caste-based parties, and of mainstream communists and socialists. So, as a prominent Congress cabinet minister concluded, “we must go back to our base, the farmers.”
Not only does the agrarian hinterland offer the current government a valuable vote bank; with some luck, it might serve to boost the national GDP-growth number. The farm sector should contribute between 18 and 21 percent to India’s 2009 GDP. Over the last four years, agriculture grew at an average rate of 3.7%; while revised price-support levels will no doubt underpin the overall size of the agricultural sector, Mr. Mukherjee and his colleagues must pray that the good weather continues. The flawed development in agricultural infrastructure since Indian independence in 1947 has ensured that the seasonal rainfall is the single largest (and uncertain) component of farm output.
It does not take a genius to calculate that the final GDP product will depend, almost entirely, on defence spending and a favourable monsoon season; the former is a certainty, the latter is in the hand of the gods.
Obviously, those buying India in the belief that the 7.1% official growth target is highly impressive in the current global environment need to examine the contents of the Interim Budget in the requisite degree of detail. More specifically, it is important to note that a good part of the defence budget is now being allocated to fighting an insurgency led by the Communist Party of India (Maoist), which exercises varying degrees of influence in at least one-quarter of India’s villages. “If we cannot abolish poverty, we are certainly facing a Nepal-like scenario in the next year or two, at least in four states,” a Congress veteran conceded last week. In Nepal, a Maoist party is in control of the country’s parliament; the Nepalese communists are closely affiliated to their Indian counterparts.
As far as the threat from cross-border terrorism is concerned, it is difficult to see what India can do stem the tide. Just this week, the Pakistani government was forced to make a peace deal with Taliban elements in the picturesque valley of Swat, a mere 150 km from the capital of Islamabad. Pakistan’s President Asif Zardari, who publicly announced that militant Islam is the biggest threat to his nation’s stability, is now asking the IMF for a further $5 billion worth of assistance to fight terrorism. And, according to reliable observers, the training camps run by radical Kashmiri jihadis along the Line of Control with India are still packed with recruits.
The conclusion: stay short India ETFs (EPI, INP, PIN, ICN) and, if you do have access to the US$/Indian rupee far forward market, short the Indian rupee. The election results in May could present a profitable exit window.
Disclosure: Short ICN, INP.